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Some people are of the opinion that all debt is bad. I don’t believe that. A judicious use of debt can be smart.
Here are six ways you can use your credit to build wealth.
1. Buy a Home
This one may seem obvious, but you really do need credit to buy a house. For many people, buying a home is a ticket to the middle class.
Let me be clear, I don’t think that buying a house is an article of faith for wealth accumulation. However, if you live in a market that isn’t too expensive, homeownership opens up a ton of wealth-building opportunities.
The most obvious way that homeownership builds wealth is through home equity. For most people, their home is their biggest asset.
You live in it, it appreciates over time, and it gives you tax advantages. This has been well discussed in many other places.
It’s quite a bit easier to start a business when you own a home. Go to any middle-class neighborhood and you’ll see construction and landscaping trucks parked in the front driveways of many homes.
I, myself, started a small lawn mowing business in my early 20s. Neither I nor my family had much income at that time.
However, because I had a lawnmower in my garage, some tools, and a truck, I could get started right away. It required no capital outlay and I was in business in the space of an hour.
You can’t do that in an apartment.
I’ve seen people run DJ businesses, catering, construction, event planning, and all sorts of over-the-internet businesses from the comfort of their homes.
Now, it’s true that you can run a computer-based business from an apartment. But even that is more complicated.
If you want to sell inventory and start an e-commerce business, a garage, a spare room, and a backyard all really come in handy. And I’m speaking from experience on this one.
Even just upgrading your internet plan can be a hassle if you live in an apartment. There are typically more internet options for people that live in homes.
I don’t recommend this, but having home equity to borrow against can be an advantage in the right circumstances.
For example, you can get a home equity line of credit to put down a down payment on a rental property to start a business or to buy an existing business.
If you’re in a tight financial spot due to health challenges or other unforeseen circumstances, having home equity is a valuable asset to you.
Furthermore, it’s more expensive to get a rental property loan if you don’t already own your own home.
If you pay off your home, it’s a valuable retirement asset. Reverse mortgages offer a significant source of income for retirees that have paid off their homes.
One last point that I don’t think many people consider is how valuable homes can be in a multi-generational sense.
Having a home large enough for adult children and their own children helps the next generation save money while they’re young and their careers aren’t earning well.
This strategy isn’t hugely popular with native-born Americans. But I admire the way that many Asian immigrants pool their resources and live in the same home well into adulthood.
Where I live in Utah, it’s quite common for adult children and their small children to live in a mother-in-law apartment, such as a basement apartment, of their parents’ home.
This is done while young couples are in college, or even while they are saving up for their first home down payment.
2. Go to Graduate School
I will be the first to admit that it’s best to get an undergraduate degree without debt. This is entirely possible.
However, it’s uncommon for students to attend graduate school without significant debt. In fact, the main argument against student loan forgiveness is that the vast majority of debt is held by high income professionals such as doctors and lawyers.
Doctors hold nine out of 10 of the most high-paying careers in the US. Attorneys, engineers, and MBAs also out-earn other careers with lesser education on average.
To this extent, I think that graduate school debt can be smart because it enables a high-paying career which, in turn, builds wealth.
Of course, many people get degrees that do not enable higher earning capacities. In this case, it would be foolish to pursue a graduate degree funded by student loan debt.
3. Start Your Own Business
As mentioned earlier, owning your own home, bought with mortgage debt, can be a springboard for starting a business.
Studies show that most small businesses have to rely on personal savings and personal debt to get off the ground.
I want to be clear that not all businesses need debt to get started. If you can start a business without debt, that’s the best option. But in the real world, many businesses require start-up capital.
While well-funded tech start-ups tend to get in the news a lot, less than one in 1000 new businesses actually receive venture capital. Most wealth is built through normal businesses, not businesses in new industries or backed with new inventions.
Getting an investor to invest in your business is a difficult and uncommon thing. Most small businesses start with the personal savings and personal debt of their owners.
A home equity line of credit is a low-interest way of providing start-up capital. But people have been known to start businesses on personal credit cards.
SBA loans are another common funding source for starting, acquiring, or expanding an existing business.
One example that we haven’t previously mentioned is starting a food truck business.
Food truck businesses, on average, require anywhere from $30,000 – $100,000 to get up and running. There’s no way most people are funding their food truck businesses without some type of debt.
Have you ever looked at how much it costs to open a McDonald’s restaurant? The franchise fees are insane.
They have net worth and liquid net worth requirements. More to the point, franchise restaurants typically require quite a bit of borrowing in order to be opened.
Construction businesses, landscaping businesses, auto mechanic shops, clothing retailers, and small-time beauty salons all require some level of debt to get started. And such proven businesses often provide the foundational wealth of many millionaires.
4. Buy Cash Flowing Assets
The real wealth-building opportunity of debt is to buy cash-flowing assets.
What is a cash-flowing asset? It’s any asset that produces income. This includes rental properties, businesses, stock-paying dividends, vending machines, websites, or even loans.
Most commonly, people use debt to buy a house and rent it out. Typically, the bank requires that you put down a down payment on the house you’re looking to buy.
You want positive cash flow from such an investment. This means that your rental income exceeds your mortgage payments, property taxes, home insurance, and other expenses.
Once you accumulate one property, you can use the positive cash flow for a down payment on your next property. Then for a third. And a fourth. And so on until you have a huge real estate portfolio.
That’s why real estate investing is a common wealth-building strategy of the rich.
They also use debt to buy businesses.
It’s common for young professionals such as dentists, chiropractors, CPAs, or young attorneys, to buy an existing practice of an older professional looking to retire.
But this is just scratching the surface.
YouTube is rife with videos on how to get rich by buying established small and medium-sized businesses. The truth is that this has always been a proven technique for building wealth.
Buying a small business with an SBA loan or low-cost financing can actually be a superbly effective business strategy.
Even publicly traded company stock can be borrowed against. Using debt to acquire public companies is not a strategy available to most people, however, wealthy people do it all the time.
A common yet little-known strategy for buying businesses is through the use of seller financing. This is also known as owner financing.
Basically, the seller agrees to accept payments from the buyer over a period of time as part of the sale agreement. Because many business buyers can’t get bank funding and don’t have the cash to buy a business, this is extremely common.
In this way, a business can be acquired without a bank or traditional lender financing.
5. Rent Authorized User Credit Card Spots
This is one that not many people know about. And it doesn’t involve getting into debt at all.
And before I get into it, let me start off by saying that I don’t recommend this practice. I’m just listing it for educational purposes, and to show that good credit truly is an income-producing asset.
Many people with bad credit can’t get approved for a credit card. If they’re trying to build their credit, that’s quite the catch-22. How can you build your credit if no one will lend to you?
This is why authorized user marketplaces were born. You can find any number of marketplaces that rent out authorized user access on a stranger’s credit card solely for the purpose of building credit.
A person with good credit and an established high-limit credit card can rent out a spot as an authorized user through such a marketplace. The person renting the authorized user slot gets an immediate boost to their credit. This is hugely beneficial for them.
Credit card companies don’t like this practice. It’s not technically illegal, but if your credit card company finds out that you’re doing it, they could cancel your credit card.
The starting cost of renting out an authorized user credit card slot is $200. The longer you’ve had that credit card, and the higher your credit limit is, the more you can rent it out for.
Some people can rent out slots on their authorized user credit cards for $1000 or even $2000.
You can have multiple authorized users on a credit card at any given time.
If I were to do this, I’d open up 10 credit cards. I’d use three to keep my credit clean, and I’d never have authorized users on them.
Then, for the other seven credit cards, I’d try to build up their values as much as possible. I’d try to get the credit limits up to 20 or 30,000 each and hold onto them forever.
If you stick with a strategy for a while, you’d see how renting out seven different credit cards for $1000 a month could be a lucrative side hustle.
Again, I don’t recommend that you do this. Credit card companies consider it fraudulent. And I’ve heard rumors that some states are considering making it an illegal practice.
6. Debt Enables Advanced Tax Strategies
If you own a financial asset, it’s likely that you can borrow against it. Since a loan is not income, the proceeds of a loan are never taxable.
This is why accountants often recommend complex strategies for borrowing assets to avoid paying taxes in certain circumstances.
For example, life insurance policies are often borrowed against to avoid paying taxes. When I used to work for a financial planning firm, we would recommend that clients build up large cash values in universal life insurance policies tied to the stock market.
The cash value of the policy grows over time. When you’re ready to retire, you can borrow against the cash value of your policy for a very low financing cost. This can be a smart tax-saving strategy if you have an insurance policy worth 1, 2, or $3 million.
Because again, the loan against the insurance policy is taxable. So any money borrowed against it can be spent tax-free. As long as the stock market is going up, the underlying value of the asset goes up.
A similar strategy can be used to borrow against 401(k)s and IRAs.
As mentioned earlier, refinancing the equity of real estate is quite common. I’ve read about investors who borrow against their properties quite liberally whenever they need cash.
They don’t mind doing this because the income of the property pays off the loan, and they can use the money tax-free for something else.
To be clear, your assets have to be significant to do this. It’s usually a strategy employed by the wealthy.
But since the value of assets generally grows over time, borrowing against assets is a common strategy that the wealthy use.
If they’re smart, they use the debt from previous assets to fund the acquisition of new assets. This is one way in which the rich get richer.
To continue learning about financial literacy, see the following articles in the series:
- Good Debt vs. Bad Debt: Know The Difference
- How To Create A Personal Balance Sheet
- Is It Better to Put a Large Down Payment on a House
- Dave Ramsey vs. Robert Kiyosaki: Who Should You Listen To?
I am a Certified Lending and Credit Specialist and first gained experience fixing my own credit. My own credit scores went from the 500s to the 800s in one year. I studied economics at The George Washington University and now have my own business working with financial technology companies. I manage my own investments and live in Salt Lake County, Utah with my wife and two kids.